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Federal Reserve Planning for More Stress Tests

Major U.S. financial institutions will be subjected to another round of the stress testing the Federal Reserve announced Tuesday. The stress testing, which is a simulation designed to determine if banks would remain healthy should worse-than-expected economic conditions continue for two years, should determine if the institutions are safe or need to increase their capital holdings.

Third Round of Tests

The Federal Reserve announced that the institutions being tested have until Jan. 9 to submit their plans that should reflect concerns about the financial conditions in Europe. The Reserve is also expanding its scope this round, including 31 different banks and financial institutions. The Supervisory Capital Assessment Program, which is publicly known as the bank stress tests even though not all of the institutions included are banks, is in its third year of annual stress tests. The first two rounds, from spring of 2009 and 2010 respectively, only covered those 19 institutions with $100 billion or more in assets. This round, though, will include those institutions with more than $50 billion or more in assets, expanding the field being subjected to the stress tests to 31 banks and financial institutions. The stress tests are required each year by the 2010 Dodd-Frank Act and force banks to submit any plans for dividend increases or stock buy-back programs to Federal scrutiny.

Big Banks in Trouble

The vigor of the stress tests only increases for those institutions with large trading operations, which will be required to demonstrate via simulation that they would be able to survive a more substantial global financial meltdown. As such, some institutions may have trouble meeting the standards being set by the Federal Reserve. Bank of America (BAC) for instance, has long been a whipping boy of the Reserve. The first round of stress tests resulted in the company being required to increase tier 1 common capital by $33.9 billion, more than double that required of any other bank, while the second round resulted in the Fed rejecting the bank's plan to increase their dividend in the second half of 2011.

Now, Bank of America is being included with six institutions with large trading operations, along with Goldman Sachs (GS), Citigroup (C), JP Morgan Chase (JPM), Morgan Stanley (MS), and Wells Fargo (WFC), that will be subjected to even further scrutiny in response to concerns over the European debt crisis. These six banks will be tested for conditions surrounding a more severe global financial meltdown to determine if they're healthy enough to survive such a debacle.

Bank of America has been operating under a memorandum of understanding ever since the first stress test in 2009, locking horns with regulators over the bank's purchase of Merrill Lynch and issues of liquidity, and regulators met with the bank's board in recent months to express their desire to see more movement towards compliance from the bank lest the memo go from being a private, informal order to a public, formal one. Now, with the bank facing stress tests, Bank of America could be facing increased scrutiny from the Federal Reserve.

Banks Angry Over Timing, Expanded Field

The 12 new banks to be forced to undergo the stress tests by Dodd-Frank's expansion to all institutions with more than $50 billion in assets will most likely bristle at the new requirement. "It's another layer of Fed oversight on their capital, and they've fought tooth and nail not to be included in this," Paul Miller, analyst at FBR Capital Markets, told Reuters. "So I don't think any of those banks are particularly happy right now." Many of the banks set to be subjected to the stress tests also expressed outrage over the timing of the new round. With banks required to submit plans by Jan. 9, those departments responsible for completing the plans will have to work through the Christmas holiday to be finished in time. "There's a ban on vacation time for the staff involved," one bank executive said to The Financial Times.

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